Small businesses should aid workers' retirement

Aug. 25, 2011 12:00 AM

Question: As a small-business owner, should I establish a retirement plan? If so, what do you recommend?

Answer: Retirement plans are a terrific way for small-business owners and their employees to tax-shelter a healthy portion of their earnings. If you don't have employees, regularly contributing to one of these plans usually is a no-brainer. With employees, the decision is a bit more complicated, but contributing is still often a great idea because of the value in attracting and retaining good employees.

Self-employed people may contribute to Keoghs or Simplified Employee Pension Individual Retirement Accounts. Small businesses with a number of employees should also consider 401(k) and SIMPLE plans.

With SEP-IRA and Keogh plans, if you have employees, you're required to make contributions on their behalf that are comparable to the company owners' contributions (as a percentage of salary) under these plans. Some employees who are part time (working fewer than 500 or 1,000 hours per year) and newer (with less than a few years of service) may be excluded.

Small-business owners often set up plans for themselves but fail to cover their employees because either they don't know about this requirement or they choose to ignore it. Be warned: The IRS and state tax authorities may discover that you've neglected to make contributions for eligible employees, sock you with big penalties and disqualify your prior contributions. Because self-employed people and small businesses get their taxes audited at a relatively high rate, don't take risks in this area.

Also, don't avoid establishing a retirement-savings plan for your business just because you have employees and you don't want to make contributions on their behalf. In the long run, you build the contributions that you make for your employees into their total compensation packages, which include salary and other benefits like health insurance. Making retirement contributions need not increase your personnel costs.

Simplified Employee Pension Individual Retirement Account plans, which are geared to owners, require minimal paperwork to set up. They allow you to sock away up to 20 percent of your self-employment income (business revenue minus expenses), up to a maximum of $49,000 for 2011.

Each year, you decide the amount that you want to contribute - the plan has no minimum requirement. Your contributions to a SEP-IRA are deducted from your taxable income, saving you on federal and state taxes. As with other retirement plans, your money compounds without taxation until withdrawal.

Keogh plans require a bit more paperwork to set up and administer than SEP-IRAs. The main difference, and attraction, of Keogh plans now is that they allow you, the small-business owner, to maximize contributions relative to employees in two ways that you can't with SEP-IRAs:

 Vesting schedules: Keogh plans allow vesting schedules, which require employees to remain with the company a specified number of years before they earn the right to their full retirement-account balances.

Vesting refers to the portion of the money in a retirement account that's owned by the employee. After a certain number of years, employees become fully vested and, therefore, own 100 percent of the funds in their retirement accounts.

If they leave before being fully vested, they lose the unvested balance, which reverts to the remaining plan participants. Thus, you've given employees a good reason to stay rather than leave.

 Social Security integration: Keogh plans allow for integration, which allows high-income earners at your company (usually you and the other owners or executives) to receive larger-percentage contributions for their accounts than the less highly compensated employees.

The logic behind this idea is that Social Security benefits top out for higher-income earners and replace a much smaller portion of their earnings than for a lower-income earner.